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VW is wrong to seek to clear its leadership over its diesel scandal

Volkswagen Group continues to amaze me. The outrage over automaker's plan to pay its top management 35 million euros ($40 million) in bonuses for 2015 should give its supervisory board cause to reflect.

Not so.

VW is asking shareholders at its June 22 annual meeting to ratify the actions of both the management board and supervisory board for last year – effectively giving them all a passing grade despite the company's emissions-rigging scandal and its record loss in 2015.

VW is taking a 16.2 billion euro charge from the scandal and the costs will rise very steeply when future fines and compensation are factored in. The supervisory board's request also flies in the face of the external investigation that is U.S. law firm Jones Day is carrying out. The probe is due to due be finished in the fourth quarter and VW is refusing to release even preliminary findings to shareholders.

"According to information currently available, no serious and manifest breaches of duty on the part of any serving or former members of the Board of Management have been established that would stand in the way of granting ratification at this time," VW said in justification of its recommendation.

VW did not mention an ongoing probe by Germany's securities market regulator, Bafin, over whether the company violated disclosure requirements by not informing shareholders of the upcoming diesel scandal before it became public on Sept. 18.

VW says its recommendation to shareholders does not waive the possibility of the company seeking compensation from executives at a later stage once the investigation if complete. This is a distinct possibility given VW itself has confirmed former CEO Martin Winterkorn received two separate memos flagging the issue in May 2014 and then again in November that year.

'Fiduciary formality'

But by effectively giving senior executives including CEO Matthias Mueller the all-clear before the Jones Day probe is completed, its seems that VW sees the investigation as little more than a fiduciary formality.

Under German law, an annual meeting can approve a proposal to forego damage claims and VW has the votes to push through such a measure thanks to its shareholder structure.

VW should delay a ratification vote that could quite possibly be contested later in court. When VW's truck unit, MAN, suffered scandals surrounding two core units it did exactly that for three years.

"The legitimate thing to do would have been to postpone a vote until all of the investigations are over, but Volkswagen is like a circle of wagons that bands together to defend itself against outsiders in times like this," Ulrich Hocker, President of Germany's shareholder rights advocate DSW, told me.

A source close to the supervisory board said there was a long discussion lasting well into the night over whether to hold the vote at a later date, but the board eventually decided against it because doing so "might inadvertently trigger speculation that someone in management indeed may have known something."

"Typically if a CEO's performance is not ratified then that person is morally expected to resign," Hocker said. "But not just then – an executive's chair can already begin to shake if the approval rating is low – consider Anshu Jain from Deutsche Bank who stepped down last year after receiving only 60 percent."

Shareholder unrest

As the annual meeting date gets close, the issue could blow up in VW's face.

Proxy advisor ISS typically issues voting recommendations two to three weeksto a large number of funds and while few own the ordinary shares that permit a say in the company, it would nonetheless send a strong signal if it recommend a vote against the board.

The activist hedge fund TCI has bought a 2 percent stake in VW stake hoping to shake things up. Its founder, Chris Hohn, said last week that VW's total payments of 400 million euros to its management board over the past six years was "corporate excess on an epic scale" and a reward for failure.

VW Group's ownership structure that concentrates virtually all voting power in the hands of three large stakeholders – the Porsche-Piech family's investment holding Porsche SE, the German state of Lower Saxony and Qatar Investment Authority. Since all three control the supervisory board together with labor unions, the board's recommendation is certain to be ratified at the June 22 meeting.

The ratification will be irrelevant in any case. VW says "regaining trust will be our most important task" but endorsing management's actions ahead of the Jones Day investigation's completion will show there is no substance in this message.

It appears that VW's leadership is playing a waiting game hoping the diesel scandal will blow over. So far they have badly misjudged public reaction in the U.S. and, at least concerning the bonuses, even within Germany.

I would be surprised if they get away this time. Judging from headlines such as this one in the German business daily Handelsblatt "Volkswagen washes itself clean," they won't.